Cardinal diversifies with Kinray deal

By Jim Frederick

DUBLIN, Ohio — Say goodbye to Kinray, the service-obsessed regional drug wholesaler. But say hello to a more muscular and diversified Cardinal Health.

The wholesale and health services giant announced Nov. 18 it will buy Kinray for $1.3 billion. The buyout, set for completion in early 2011, will be a boon to Cardinal, boosting its customer base to more than 7,000 independent drug stores, extending its reach in the Northeast and adding scale versus its wholesale rivals, McKesson and AmerisourceBergen.

Equally important, the addition of Kinray’s 2,000 independent customers in the New York/New Jersey metro area propels the company ahead in its efforts to diversify its customer base, which in recent years has become precariously dependent on two chain pharmacy giants, Walgreens and CVS, for half of its distribution revenues.

“The acquisition grows [Cardinal’s] base of customers by [more than] 40%,” said Adam Fein, founder and president of Pembroke Consulting. However, he warned, “they’re going to have a big challenge in retaining those customers. Kinray had a unique reputation.”

Indeed, Kinray’s service reputation and close ties to independents are legendary. Applying that kind of personalized culture to the much bigger scale of Cardinal’s business model will be challenging, but Cardinal chairman and CEO George Barrett appears to put a high premium on Kinray’s customer service standards, saying his company will work “to continue that tradition.” And Kinray’s customers, he said, will benefit from Cardinal’s “branded pharmaceutical programs, inventory and pharmacy management tools, and ... extensive generic drug program.”

For Kinray, it’s the end of a remarkable, 36-year run as a privately owned juggernaut, and a bonanza for its owner and CEO, the colorful and socially connected philanthropist and billionaire Stewart Rahr. Beginning in the 1970s, Rahr built the Whitestone, N.Y.-based company into a distribution powerhouse, thanks to an obsessive commitment to personalized, responsive service; high-tech order and fulfillment muscle; and rapid order turnaround. Kinray ships prescription and over-the-counter medicines, health-and-beauty aids and home health products across the United States, but its real strength lies in the Northeast, where it generates most of its $3.5 billion in annual revenues.

One thing that motivated Rahr to exit the market now, Fein observed, is “the level of competition in the wholesale market. Margins are continually under pressure, and the scale to buy generic drugs is crucially important.”

That last factor, he told Drug Store News, will work to Cardinal’s advantage, given the company’s massive generic purchasing and distribution capabilities and economies of scale.

On the other hand, Fein said, “Cardinal ... has numerous challenges in rebuilding a position in the independent market,” given its efforts to rejuvenate its Medicine Shoppe franchise program. With Kinray, “they’ve acquired a company that has a reputation, culture and heritage in serving that customer very well. That’s a big net positive for them,” Fein added.

Cardinal also is restructuring its Leader marketing program for independents, Fein noted. “Their over-focus on large customers, and the big competitive threat from Health Mart, has really put them in a defensive posture. So they’re trying to go on the offensive by restructuring Leader, bringing new management to Medicine Shoppe and acquiring Kinray,” he said.

Wall Street endorsed the deal. Standard & Poor’s upgraded its investment rating on Cardinal to “buy,” noting that the acquisition provides the wholesale giant with “needed diversification, since 57% of [Cardinal’s fiscal 2010] revenues comprised only five customers.”

Morgan Stanley Research called the Kinray acquisition the “optimal use of cash” for Cardinal, giving it “greater exposure to independent pharmacies ... and to generics.”